'Congratulations': EU moves to Brexit phase two but warns will be tough

Britain's Prime Minister Theresa May arrives to attend the European Union summit in Brussels, Belgium, December 14, 2017. REUTERS/Yves Herman

By Robin Emmott and Alastair Macdonald

BRUSSELS (Reuters) - The European Union agreed on Friday to move Brexit talks onto trade and a transition pact but some leaders cautioned that the final year of divorce negotiations before Britain's exit could be fraught with peril.

EU leaders, who had offered British Prime Minister Theresa May a rare summit round of applause over dinner in Brussels the night before, took just 10 minutes to agree that she had made "sufficient progress" on divorce terms last week and to give negotiators a mandate to move on to the main phase of talks.

"This is an important step on the road to delivering the smooth and orderly Brexit that people voted for in June of last year," May said outside her home in Berkshire, southern England.

"There is still more to do but we're well on the road to delivering a Brexit that will make Britain prosperous, strong and secure," May said, reassuring her party's ardent Brexit supporters that departure is certain on March 29, 2019.

Summit chair Donald Tusk said the world's biggest trading bloc would start "exploratory contacts" with Britain on what London wants in a future trade relationship, as well as starting discussion on the immediate post-Brexit transition.

A transition period is crucial for investors and businesses who fear that a "cliff-edge" Brexit would disrupt trade flows and sow chaos through financial markets.

The head of the EU executive, Jean-Claude Juncker, cast May as a "tough, smart, polite and friendly negotiator" -- a polite nod to a woman facing ferocious and complex pressures at home, whose downfall Brussels fears would complicate talks further.

Juncker, a veteran premier of Luxembourg, knows "what it's like to be a prime minister in trouble", one EU official said.

NOW FOR THE HARD PART

While there was a "sigh of relief" at the summit table that Brexit talks can move forward, EU leaders said talks on a future free trade pact will not begin until after March -- a date underlined by "guidelines" that set out how to proceed as Britain seeks to unravel more than 40 years of membership.

The talks will be tough.

"We have made good progress, the second phase of talks can start," German Chancellor Angela Merkel said. "But this will mean even tougher work - that was clear today in the discussion - than we have experienced so far."

Sterling reversed gains and fell 0.8 percent on the day to $1.3327.

Austrian Chancellor Christian Kern went further, saying even a primary school student could see that the "first phase" deal on the Irish border would come back to haunt the talks because it was impossible for Britain to leave the bloc's single market while avoiding a hard border on the island of Ireland.

"Our primary school students can see that there is a riddle to be solved," the Austrian leader told reporters.

In more formal language, leaders used the nine-point guidelines they agreed at the summit to support May's call for a two-year transition out of the bloc, which aims to help British business and citizens adjust to life after the European Union.

Both sides see it as looking pretty much like membership of the EU without a say in its rules, though there are also a host of issues that will again demonstrate the complexity of Brexit.

Leaders reiterated their position that Britain cannot conclude a free-trade accord with the European Union until it has left and become a "third country". And it may take longer than the 15 months from now that some in London are hoping for.

Noting a call from Britain's Brexit Secretary David Davis for a "Canada plus plus plus" deal that would go beyond the pact the EU signed with Ottawa, one senior EU official noted that last year's agreement ran to 1,598 pages of legal text.

"Nine months on Brexit have produced 15 pages of non-legal text," he said, adding that even launching trade talks in March would be "quite ambitious", let alone completing them in 2019.

"DIVERGENT OPINIONS"

In coded language aimed at ensuring that Britain's departure will not set a precedent for others and further undermine the bloc, leaders also agreed to "ensure a balance of rights and obligations" during Britain's transition period.

The question of how Britain might continue to benefit from the EU's free trade deals with other countries, such as Canada or Japan, has yet to be settled legally, EU officials said.

Irish Prime Minister Leo Varadkar cautioned that there were "quite divergent opinions" on how a new relationship and transition would look. EU officials are unsure exactly how far Britain should continue to receive the full, unfettered economic benefits of EU membership during a transition after it leaves, even if it loses political representation in Brussels.

May, weakened after losing her Conservative Party's majority in a June election, has so far carried her divided government and party with her as she negotiated the first phase of talks.

But the next, more decisive phase is likely to lay bare the deep rifts among her top team of ministers over what Britain should become after Brexit.

The Dutch, traditionally British allies, said May should explain to voters just what the cost of leaving the EU's single market and customs union would mean for the economy.

"It means, for example, that the financial sector of London will have a considerable disadvantage to the position they have now," Prime Minister Mark Rutte said.